Friday, July 23, 2021

Google, Bermuda, and Effective Tax Rates

In its 2020 annual report Google noted that:

As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S.

As a result of this change, royalty payments from Ireland which previous ended up in Bermuda, via The Netherlands, now flow directly to the United States. Here we will assess the impact the structure had on Google’s taxes over its entire duration from 2003 to 2019.

Google Foreign Domestic and Tax 2003-2019

Over the full period, Google had an effective tax rate of 21.8 per cent.  The contributions to this were a foreign tax rate of 7.1 per cent and a domestic, i.e. US, tax rate of 39.8 per cent.

Much attention has been given to Google’s foreign tax rate, particularly those of 2005 to 2011 which averaged just 2.3 per cent.  This was primarily the result of a large share of Google’s foreign profit being reported in Bermuda, which, of course, does not have a corporate income tax.

However, the full picture requires the assessments to incorporate Google’s domestic, i.e. US, and then overall tax rates.  From 2005 to 2011, when its effective foreign tax rate averaged 2.3 per cent, Google’s overall effective tax rate averaged 24.7 per cent.

The domestic tax rate for 2017 is also notable. At 120 per cent the domestic tax charge for the year exceeded domestic pre-tax income.  This is because it included the US tax due under the “deemed repatriation tax”.  This is domestic US tax but is due on foreign profit.  As the company set out in its 2018 10K report:

The Tax Act requires us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion.

Over the period 2003 to 2017 Google had a domestic tax rate of 49 per cent.  This is not because the US had corporate tax rates as high as that but because included in domestic taxes are the US taxes due on foreign profits, most notably the profits Google reported in Bermuda.

It is a numerator/denominator issue.  A focus on foreign income and foreign taxes omits the domestic, that is US, tax paid on those profits.  The effective tax rate on Google’s foreign profits was not the 2.3 per cent implied by the effective foreign tax rate.  Indeed the lower Google, and similar MNCs can get their foreign tax rate, the higher their domestic tax rate will be.  And, from 2003 to 2017, nearly 90 per cent of Google’s income tax charge was for US taxes.

The above table also illustrates the impact of the Tax Cuts and Jobs Act which came into effect from the start of 2018.  For the years shown, Google’s lowest domestic and overall effective tax rates arose in 2018 and 2019.  As a result of the TCJA, Google’s overall effective tax rate, which in aggregate terms was 25.8 per cent from 2003 to 2017, was reduced to 12.7 per cent when 2018 and 2019 are combined.

And finally a table from Google’s most recent 10K report which shows the impact of the company its licensing arrangements in Bermuda:

Google 10K 2020 Domestic Foreign Income

For 2020 there was a large rise in Google’s pre-tax income that was attributed to domestic operations and a commensurate fall in pre-tax income attributed to foreign operations.  Google’s profit is now being reported where most of it is generated: in the US. And because of the TCJA Google will have a lower overall effective tax rate than when it is was shifting tens of billions of profit to Bermuda.

What’s going on with the current account?

Ireland’s balance of payments is subject to huge volatility.  Among the reasons for this are transactions in intellectual property and aircraft for leasing as well as income flows link to redomiciled, but not Irish-owned, PLCs.  In response to this the CSO have been publishing a modified current account, CA*, which strips out the above of these issues.

Getting on a handle on a country’s underlying current account position can be an important part of determining if imbalances are building up.  As the long-run series in the chart below shows, Ireland experienced widening balance of payments deficits in the late-1970s and mid-2000s which precipitated severe problems.

Current Account 1937-2020

Last week, the CSO published the 2020 estimate of the modified current account.  The surplus of €23.5 billion was equivalent to 11.5 per cent of national income.  This is an extremely large surplus by historic Irish and current international terms.

The only time Ireland ran a current account surplus of an equivalent size was during World War II when trade restrictions and rationing were in force.  Ireland’s current account needed to improve to wash out the imbalances built up prior to 2008, but the ongoing rise to record levels seems to be overstating it.

When can get some insight into this from the Institutional Sector Accounts.  The current account of the balance of payments is savings minus investment.  The sector accounts allow us to see the contribution by sector to the current account.  The chart below takes the annual outcomes from the sector accounts for saving minus investment with the figure for the non-financial corporate sector adjusted to make the total across all sectors consistent with the modified current account.

Gross Savings minus Investment by Sector Modified 1999-2020

Immediately, we are drawn to the 2020 figures.  The household sector has been a net lender since 2009 but this increased very significantly in 2020 – due to restrictions on spending.  The support incomes the government sector moved to being a significant borrower. Financial corporations and the impact of items that are not sectorised have not had much impact on the current account in the last four or five years.

That leaves us with the red segment of the bars – the adjusted figure for non-financial corporations.  For the last few years this has been making a positive contribution to the current account and last year it was €12.5 billion.

For the time being we don’t have much insight into this.  While the modified current account is showing a significant surplus some caution should be exercised before considering it available for spending.

Later in the year when the annual sector accounts are published we will get a domestic/foreign split for the corporate sectors in 2020.  Here is what the 2019 figures showed:

Gross Savings minus Investment for Domestic Sectors 2013-2019

There wasn’t really a whole lot going on the domestic sectors up to 2019.  By 2019 all of the household, government, domestic non-financial and domestic financial sectors were net lenders.

However, the most significant changes were happening within the foreign-owned sectors – those sectors we hope would be largely stripped out of the modified current account.  Either via standard net factor flows (repatriated profits etc.) or via the CA* adjustments for IP, aircraft and redomiciled PLCs. 

But even after all those the impact of foreign-owned sectors went from –€7.2 billion in 2017 to +€0.4 billion in 2019.  This was the largest contribution to the rise in the black line (the modified current account) up to 2019.

And the recent update to the modified current account shows that the 2019 figure has been revised up.  It €16.5 billion for last year’s annual sector accounts; when this years sectors accounts are published they will reflect last week’s update which put the 2019 modified current account at €20.2 billion.

It is clear there is something going on – and that it likely to be within the foreign-owned sector. What is not clear is whether it is something that would justify a further refinement of the adjustments made to get to the modified current account. 

It could be due to “good” investment such as manufacturing plants for pharmaceuticals or processors.  Or it could be another distortion that should be stripped out.

There is no doubt that Ireland’s current account has improved relative to the large deficits that were evident up to 2008 but there must be some doubt that that improvement has led to a surplus equivalent to 11.5 per cent of national income. A surplus, yes, just not a record one. 

Wednesday, July 7, 2021

Relative Calm in the 2019 Aggregate Corporation Tax Calculation

A while back the Revenue Commissioners published the 2019 update of the Aggregate Corporation Tax Calculation.  Given recent developments in Corporation Tax revenues is it perhaps surprising to note the general stability in most items in the table.

Aggregate CT Calculation for Taxable Income 2015-2019

Two of the more notable figures are for Capital Allowances used and Foreign Income.  The rise in capital allowances is linked to the onshoring of intangible assets while foreign income is a function of the worldwide nature of the Irish Corporation Tax regime.

The lower half of the table showing how Taxable Income is translated into Tax Due is also relatively stable.  All told, the €6.9 billion increase in Net Trading Income in 2019 resulted in a €728 million increase in Tax Due

Aggregate CT Calculation for Tax Due 2015-2019

In line with the increase in foreign income reported on Irish Corporation Tax returns there has been an increase in Double Taxation Relief and for the Additional Foreign Tax Credit.  These items have by largest impact in the transition from Gross Tax Due to Tax Due. The relief is because the Irish-resident companies which have this foreign income have paid tax in the source jurisdiction so are unlikely to owe any additional tax in Ireland (as the rates paid abroad will generally exceed the 12.5 per cent rate that applies here).

Use of the R&D Tax Credit rose in 2019 with increases in both the credit itself and in the Payment of the Excess R&D Tax Credit in circumstances where a company claiming the credit does not have a sufficiently large tax liability in order to be able to fully utilise the amount of the credit they are eligible for.  Combined these came to €629 million in 2019.

A rarely-looked at item is Gross Withholding Tax on Fees which increased to €367 million in 2019.  Essentially, this is to allow for tax that has already been paid.  There are a number of instances where the person making a payment for certain services must withhold 20 per cent of the fee from the recipient and transfer it to the Revenue Commissioners. 

When a company files its tax return it will include the amount of withholding tax incurred on fees it should have received.  This item reduces the amount of Tax Due but, in a manner somewhat similar to foreign tax credits, it reflects tax that has already been paid.

In the transition from Gross Tax Due to Tax Due the only item that explicitly reduces a company’s tax bill is the R&D tax credit.  If Ireland switched to a territorial regime, the need for foreign tax credits would be removed and the gap between Gross Tax Due and Net Tax would be reduced with limited impact on the liability of companies to Irish Corporation Tax.

Friday, June 18, 2021

The latest insight into Apple’s use of capital allowances

At the start of 2015, Apple revised the structure through which the company’s sales to customers outside the Americas were organised.  This was responsible for the 26 per cent real GDP growth reported for that year.

We initially examined the revised structure here and in recent years have been tracking the consolidated outcomes for the group headed by Apple’s central international subsidiary, Apple Operations International (AOI). 

The recent publication of the AOI Group’s 2020 consolidated accounts gives us the latest insight into Apple’s use of capital allowances.  The two posts above contain details that are not repeated here.

We will start with the consolidated statements of operations and note that this covers the holding company AOI and around 80 subsidiaries operating beneath it, with the group as a whole having just over 50,000 employees.  Most, but not all of the amounts shown, arise in or pass through subsidiaries in Ireland.

AOI Income Statement 2017-2020

Some pretty big numbers there.  As the accounts note:

The Group develops, manufactures and markets smartphone, personal computers, tablets, wearables, and accessories, and sells a variety of related services.

It certainly sells a lot.  For the four years shown, cumulative net sales were close to $600 billion.  And it is massively profitable.  Pre-tax income summed to $165 billion over the four years and the provision for income taxes was a chunky $25 billion.

But we should check a few things before we get excited about that tax figure.  A company making a provision for income taxes in its financial accounts is not the same as a company making a payment for those taxes in cash.  The balance sheet is a useful place to look next.

AOI Balance Sheet 2016-2020

For our purposes we are interested in the line for Deferred tax asset.  We can see that the AOI Group had $25.6 billion of deferred tax assets at the end of its 2016 financial year.  These reduced each year and by the end of its latest financial year stood at $10.9 billion.

Thus, while there might been tax provisions averaging around $6 billion in the income statement for each of the past four years this was not resulting in an equivalent payment out of cash reserves but in the reduction in the deferred tax asset on the balance sheet.

[As we have pointed out before it is also worth noting what this balance sheet does not contain: a huge amount of intangible assets.  Ireland’s national accounts have recognised massive intangible assets yet the consolidated accounts of the group which contains the company with that asset does not. Anyway back to the tax payments.]

The difference between the provision for tax and the payments for tax is is confirmed by a supplemental item included with the consolidated statements of cash flows.

AOI Cash Flow Statement 2017-2020

There might have been tax provisions of $6 billion each year but, as the final line above shows, cash payments for income taxes averaged $2 billion a year over the past four years.  And a variation of the following paragraphs are included a number of times in the accounts:

The corporate income taxes in the consolidated statements of operations, balance sheets and statement of cash flows do not include significant US-level corporate taxes borne by Apple Inc., the ultimate parent of the group.

US-level taxes are paid by Apple Inc. on investment income of the Group at the rate of 24.5% (35.0% in 2017) net of applicable foreign tax credits. In addition, under changes in US tax legislation that took effect in December 2017, Apple Inc. is subject to tax on previously deferred foreign income (at a rate of 15.5% on cash and certain other net assets and 8.0% on the remaining income), net of applicable foreign tax credits.  The new legislation also subjects certain current foreign earnings of the Group to a new minimum tax.

The posts linked above that went through AOI’s 2018 and 2019 accounts go into detail on how the provisions for income taxes were arrived at and show the reconciliation with Ireland’s 12.5 per cent headline rate.  The earlier posts also discuss how the deferred tax asset came about – capital allowances under Section 291A of the Taxes Consolidated Act. 

For now, we will just focus on the evolution of those deferred tax assets using a table from the note to the accounts on the provision for income taxes.

AOI Deferred Tax Assets 2017-2020

We are interested in the deferred tax asset that arises due to Intra Group Transactions.  This likely includes the purchase by a now Irish-resident subsidiary of the license to sell Apple products in all markets outside the Americas.  That outlay (which may have been around $240 billion) will be eligible as a tax deduction with this provided via capital allowances.

At Ireland’s 12.5 rate of corporate tax a $240 billion deduction would be worth $30 billion which is probably where the value of the group’s deferred tax asset from intra-group transactions was in January 2015.

As we can see from the above table tax was being charged against that deferred tax asset.  The utilisation was $4.4 billion in both 2017 and 2018, $3.2 billion in 2018 and $3.3 billion in 2020.  This meant there was $7.4 billion remaining and at the current rate of utilisation will be fully exhausted in the next two to two and a half years.

The utilisation of capital allowances at that scale means that something in and around €25 billion of gross profit is being offset by a deduction for capital allowances.  As the transaction occurred before October 2017 no cap applies and, if sufficient capital allowances are available, the company can fully offset its profit with capital allowances and this is was happened in 2015, 2016 and 2017.  A small amount of profit may have been subject to tax in 2018.  Any unused capital allowances in the earlier years are carried forward as losses but essentially remain as a deferred tax asset.

As before, the key question is the amount of profit that will be subject to tax when the deferred tax asset is fully exhausted.  If nothing changes at that point then somewhere in the region of €25 billion of gross profit will be added to the taxable income of the Irish-resident Apple subsidiary that currently holds the license to sell Apple products outside the Americas. 

This would see tax payments in Ireland rise by €3 billion or so and that Apple subsidiary would almost certainly become Ireland’s largest taxpayer.  If nothing changes.

We have already seen a number of major US ICT MNCs transfer their IP back to the US (from which it should never have been allowed leave in the first place).  Apple have the option to do the same and maybe this becomes more likely as the amount of capital allowances available nears exhaustion.

If Apple were to do so, this would reverse the GDP surge that occurred in 2015 and the value added would be rightfully recorded where it is generated – in the US.  Changes that add 0.2 per cent to US GDP won’t make headlines in the same way a 10 per cent reduction in Irish GDP would.  But they essentially involve the same thing.

And further it probably won’t significantly change the company’s tax payments  - not in Ireland at any rate.  With capital allowances the profit is not currently exposed to Ireland’s 12.5 per cent Corporation Tax.  As pointed out above the profit is subject to tax in the US under the minimum tax on foreign earnings introduced by the Tax Cuts and Jobs Act (TCJA). 

This is the tax on Global Intangible Low Taxed Income – GILTI.  The Biden administration are proposed to double this from 10.5 per cent to 21 per cent.  If Apple relocates their IP to the US and continues to use a licensing structure (they could also decide to simply sell the products from the US) then the income from that license would be taxes under the Foreign Derived Intangible Income (FDII) provisions also introduced by the TCJA.  The Biden administration are proposing to abolish FDII.

There is lots of uncertainty.  But as shown here there is no doubt that the amount of remaining capital allowances Apple has in Ireland is reducing.  What was probably around $30 billion in 2015 was down to $7.4 billion in September 2020.  We won’t get many more insights into Apple’s use of capital allowances – because soon enough they will be gone. 

Monday, June 14, 2021

Why there’s no pot of gold from suggestions of German multinationals reporting low-taxed profit in Ireland

Last week’s New York Times op-ed by Prof. Paul Krugman got some attention though mainly for some of the characterisations used.  And there is a difference between a pithy remark about a set of national accounts and the pejorative use of language to describe the residents of a country.

But let’s focus on the substance of some of the points made and, in particular, this extract which draws on some comments made by Prof. Gabriel Zucman on the recent G7 agreement:

Which brings us to that G7 deal. How would the 15 per cent minimum rate work? Here’s how Gabriel Zucman – who has arguably done more than anyone else to highlight the importance of international tax avoidance – summarises it:

“Take a German multinational that books income in Ireland, taxed at an effective rate of 5 per cent. Germany will now collect an extra 10 per cent tax to arrive at a rate of 15 per cent – same for profits booked by German multinationals in Bermuda, Singapore, etc.”

It seems it is to be taken as given that the suggestion of a German multinational booking profits in Ireland is a relevant example.  But has there ever been evidence of German multinationals with profits booked in Ireland and taxed at five per cent?  Unfortunately, Germany has yet to provide aggregate data to the OECD from the country-by-country reports filed by German multinationals with the German tax authority.

There is, though, this recent CESifo working paper which uses the firm-level reports filed with the German tax authority to assess profit shifting by German multinationals. The conclusion of the paper includes the following:

However, compared to the profits in non-haven countries, profits reported in tax havens are small – only accounting for 9% of global profits.

[.]

Our findings suggest that annually, EUR 3.8 billion of EUR 125 billion of total foreign profits of German MNEs are shifted to tax havens, yielding a share of approximately 3%.

In general, estimates of the extent of profit shifting in the literature tend to be higher, although some studies, in particular Blouin and Robinson (2020), find similar magnitudes. The differences in the results may result from different methods or data sources, but they may also reveal that German MNEs are less prone to shift profits than MNEs from other countries. That in turn could reflect tighter anti-tax avoidance policies in Germany and in important host countries of German foreign investment. Another reason could be differences in profit shifting opportunities due to firm characteristics such as the importance of intangible assets.

The final points on policy and opportunities are important considerations when examining US multinationals.  While we don’t have aggregate data for German multinationals from country-by-country reports there are other salient sources that can be used.  One is Eurostat’s dataset on foreign-controlled EU enterprises.

It is not a perfect match for tax data but does point in the right direction.  Here is the gross operating surplus of foreign enterprises operating in Ireland in 2018 by controlling country.  This measure is not the same as taxable income and gross means before any adjustment for depreciation.

GOS in Ireland by Controlling Country 2018

It it clear that there is only one bar that matters.  Most of the other numbers are non-zero but are not large enough to be visible due to the axis range needed to include the figure for the US.  Germany is up towards the top of the chart and the gross operating surplus in Ireland of German-controlled enterprises is small compared to that of US-controlled enterprises.

We can see more detail of the distribution of profits of German companies across EU countries with the following table which shows the gross operating surplus of enterprises ultimately controlled from Germany by the location of those enterprises.

GOS of German controlled enterprises in EU countries

Unsurprisingly, the vast majority of the profits of German controlled-enterprises is generated in Germany.  The figures for Germany in the table include both multinational and non-multinational enterprises.  For German multinational enterprises, the rest of the table gives the amount of gross operating surplus they record in other EU countries.  The table is in rank order based on the most recently available outturn.

For Ireland, we can see that the figure has typically been around €1.2 billion in recent years which can be compared to the €117 billion of gross operating surplus that US MNEs had in Ireland in 2018.

In the above table, Ireland is below Finland, Portugal, Denmark, Slovakia and Sweden as a location for the profits of German MNEs.  And that €1.2 billion will include the profit of Germany companies which have come to Ireland to service the domestic market such as grocery retailers.

Having people take an example of a German company booking profit in Ireland stumbles on two bases. First, in overall terms, German companies do not shift large amounts of their profits to low-tax jurisdictions (likely because they can not do so under German law). And, second, aggregate data suggests that German companies do not report significant amounts of profit in Ireland (unlike US companies).

Indeed, using an approach that is incorrect but frequently used, the argument could be made that German companies are shifting profit out of Ireland.  Here are the recent accounts for BMW Automotive (Ireland) Ltd.

BMW Ireland 2019

For the years shown BMW sold about 5,000 vehicles in Ireland – across its BMW and Mini brands.  The sale of these vehicles generates the revenue for this company.  In 2019, it can be seen that after €147 million of cost of sales and €9 million of administrative expenses the company recorded an operating profit of €871,000 and incurred an income tax expenses of €120,000 (or around €24 per vehicle sold).

In 2019, BMW as a whole had revenue of €104 billion and a pre-tax profit of €7 billion.  The overall margin of the company was around 15 times higher than the margin reported by BMW Automotive (Ireland).  Why was BMW’s Irish subsidiary so unprofitable?  The result was mainly driven by the cost of sales figure.

The cost of sales is the price BMW in Ireland had to pay for the cars it sells.  It is a transfer price.  And BMW has set this price at such a level that almost no profit is left in Ireland.  Most of the profit will be reported in Germany. 

And this fine.  BMW Automotive (Ireland) does little more than wholesale cars.  It has very limited functions, assets and risks and a low profit margin is appropriate.  The designing, manufacturing, branding, pricing and lots of other things necessary before a BMW car can be sold all take place somewhere else.

Why doesn’t BMW manipulate the transfer price so that more of its profit is reported in low-tax Ireland rather than high-tax Germany? It can’t.  BMW Germany has to charge BMW Ireland the same price it charges to other wholesalers of its vehicles. 

BMW could try to have more of its profit reported in Ireland by charging BMW Ireland a much lower price.  But the German tax authority would simply ask for the price charged in other similar transactions and challenge the transfer price used.  Just as they would for all other German MNEs that might try to shift profit to Ireland. 

There might be suggestions of German MNE booking profit in Ireland to be taxed at five per cent but there aren’t many examples of it. 

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